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Rare Disasters, Tail Aversion, and Asset Pricing Puzzles

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  • Gerrit Meyerheim

Abstract

This paper develops a parsimonious consumption-based asset pricing model that integrates tail aversion, implemented via a one-period entropic tilt, with rare disasters under CRRA utility. Closed-form expressions for the risk-free rate, return moments, and the Hansen-Jagannathan bound yield an analytic mapping from moments to structural parameters and bounds on risk aversion. Calibrated to long-run return data and disciplined by disaster evidence, the model reconciles the equity premium and risk-free rate puzzles with very modest risk aversion. The same calibration generates an option-implied variance risk premium, realistic crash insurance prices, and a two-component Black-Scholes mixture with a moderate downward-sloping implied volatility skew.

Suggested Citation

  • Gerrit Meyerheim, 2025. "Rare Disasters, Tail Aversion, and Asset Pricing Puzzles," CESifo Working Paper Series 12231, CESifo.
    • Handle: RePEc:ces:ceswps:_12231
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    References listed on IDEAS

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    Keywords

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    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty

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